NIZAM HAMID<br /><strong>HEAD OF SALES STRATEGY, SHARES</strong><br /><br />IIT IS often said that one of the biggest advantages of having Exchange Traded Funds (ETFs) in your portfolio is that ETFs are inherently diverse, because they are based on an underlying basket of securities&nbsp; and are available on a wide range of asset classes.&nbsp; The financial crisis highlighted the potential of diversification in limiting losses and minimising investors&rsquo; exposure to risk and volatility. <br /><br />One way in which investors tried to lower their portfolios&rsquo; volatility and earn steadier returns was by switching into the relatively safe asset class of fixed income to balance the overall risk. <br /><br />At the moment, investors appear to be focusing on six different types of risk: interest rate uncertainty; inflation outlook uncertainty; changes in the credit markets; liquidity; economic growth; and political risk. The latter can range from what happens in terms of recapitalising the banking sector to emerging markets defaulting on debt.&nbsp; <br /><br />Depending on what investors are most worried about, they will want to diversify their portfolio in different ways, and the wide range of ETFs allows them to tailor their exposure. Attitudes to all these types of risk can vary over time but the added liquidity in ETFs allow investors to fine tune their portfolios. <br /><br />For example, if you are worried about the outlook for inflation then there are inflation-linked ETFs. Alternatively, if you expect inflation to rise over the coming months, then you might expect this to feed through into more buoyant property markets and thus buy property ETFs.<br /><br />If you are concerned about relatively illiquid markets but still want exposure to high reward and high risk, then ETFs can give you easier access to assets such as corporate bonds, small caps, emerging markets and basic resources. <br /><br />But if you want to minimise your risk exposure then you can also create a balanced portfolio and perhaps increase slightly your exposure to government bonds. Fixed income has seen a quarter of all asset flows over the month, which shows&nbsp; investors are increasingly being drawn to ETFs to implement diversification and asset allocation strategies.<br />